Basics Of Value Added Tax
Basics Of Value Added Tax
The Value Added Tax (VAT) is a tax on the value added by any business intermediary through his own activity on the goods and services (Inputs) it buys from the other business intermediaries. In the modern production distribution chain, a product goes through different stages of manufacture and then through different stages of distribution before it reaches the final consumer. Example: Primary producers of steel like TISCO and SAIL make HR coils, which are sold to Cold rolling units. Cold rolling units make CR coils and sell these to different industries like auto parts manufacturers, steel furniture manufacturers etc. These final products like steel furniture are then sold to Distributors, which in turn sell these to Retailers, Retailers sell these to final customer, who is the user of these steel furniture. In this entire process of manufacture of HR steel to purchase of furniture by a customer, the product moved from one intermediary to another till it finally reaches to the customer. In this total chain, the output of first intermediary becomes the input of second intermediary, output of second intermediary becomes the input of third intermediary and so on. Each intermediary does his part of the activity on the product to make it good for use by the next intermediary, this is called Value Addition. Value addition tax is the tax on this value.
Thus, VAT is a multi stage Consumption or Production tax, which is applied to the sale of goods at the various stages of production and distribution chain. At each stage, tax is calculated on Sales (Output) and Vendors are able to able to claim tax credits to recover the tax paid on their purchases (inputs). This results in charging of tax only on the value added portion of each vendor. In our above example, Tax of Rs. 1,400 (10% of Rs. 14,000) will be calculated on sales of CR maker. He will be allowed credit of Rs. 1,200 i.e. the tax paid by him on his purchases from HR maker. Thus he will pay only Rs. 200 (equals 10% tax on his value addition of Rs. 2,000) as tax. The input tax credit is not allowed to the final seller in the chain i.e. Retailer in our example.
The incidence of tax in both the systems is the same i.e. 10% VAT is equal to 10% retail sales tax. It may be noted in our above example that the total amount of tax collected in the total chain of manufacture to sale of furniture to final consumer is Rs. 2,100 (Rs. 1200 + 200 + 400 + 100 + 200), it is the same amount i.e. 10% of Rs. 21,000 which would have been collected in the system of Retail sales tax. Thus difference between VAT and Retail sales tax is that VAT is collected in pieces at each stage which equals the tax on retail sale collected in one lump at the final stage.